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Wells Fargo & Co Stock Is a Rough Diamond — Go Long

Year-to-date, Wells Fargo & Co (NYSE:WFC) stock is lagging the group, down 10% while other bank stocks like Bank of America Corp (NYSE:BAC) and JPMorgan Chase & Co. (NYSE:JPM) are 10 points better off. Mostly it’s due to WFC stock’s self-inflected wounds. We all know the scrutiny Wells Fargo has been under stemming from their pushy sales tactics and related customer fraud — but therein lies part of the thesis today.

WFC stock so far has been able to withstand selling pressure from tremendous market-wide fears, its own inflammatory headlines and tremendous global volatility, and has remained in line with price expectations. I believe most of the froth has been shed from the stock and it could be ready to bounce from the malaise. More on this in details later.

But since we’ve seen boneheaded moves from management, I don’t want to buy the shares outright and leave myself with no room for error. Instead I use options, where I can get long WFC for no money out of pocket. I can do this in stocks where I see tangible value but need some buffer between the price and my risk.

Fundamentally, WFC is cheap from an absolute and relative standpoint. It sells at 13 price-to-earnings ratio and 1.5 times book value, so owning the shares — especially if at a discount from the current price — will definitely be an opportunity for long-term profits.

Technically there is risk in Wells Fargo stock. Since February, it had been setting lower highs and bumping along a bottom, thereby forming a neckline around $50 per share. If this neckline breaks for any reason, then it would open a trap door for another leg lower. For now, Wells Fargo stock has used it as a springboard for a 9% bounce. The upside target could eventually be $58 per share.

My trade today won’t need a rally to profit, though if one comes then my profits would come faster. Since we have threat to stocks from U.S./China headline risks, I trust proven support more than upside hopium. Banks are cheap — click here for details and get an ongoing free copy of my weekly newsletters.

KSS Stock Trade Ideas

The Trade: Sell the WFC Jan 2019 $47 put for $1.10. Here I have a 85% theoretical chance of success. Otherwise and if the price falls below that level then I would suffer losses below $45.90.

Selling naked puts is daunting. Those who want to mitigate that risk can sell spreads instead.

The Alternate Trade: Sell the WFC Jan 2019 $47/$45 credit put spread, where I have about the same odds of winning but with much smaller risk. The spread would yield 18% if successful.

Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.